QE may be winding down but no rate rises yet

After injecting a whopping £200 billion into the quantitative easing programme over the past nine months it now seems as though the Bank is embarking on the "wind-down" stage of quantitative easing, weaning the economy and the financial markets off their life-support system.

That is not to say they are going to start taking back the injections, just that they will be undertaken at a much slower rate.

The way the Bank will do this is to drag out the extra £25 billion of asset purchases over the next three months. That's half the rate at which it injected money over the previous three months. And come February next year, when this latest round of QE is complete, the Bank will probably tell us it has finished its asset purchase programme altogether.

Why this downsizing (and eventual phasing out) of money injections? The Bank's monetary policy committee is beginning to sound more comfortable that the recovery is finally happening, even if it is delayed (after all, the economy continued to contract during the third quarter of this year).

Today the Bank talked of improving global growth and financial market conditions, higher asset prices, and a likely return to growth soon in the UK – encouraging news indeed. Inflation is also likely to rise over the coming months.

But it will probably have to maintain policy accommodation for some time, keeping interest rates low (at 0.5%) and holding on to the assets it has bought in its QE scheme.

The reasons, as the Bank said today, are that activity is weak (even though it's recovering), financial conditions are still far from healthy, the need to reduce debt will limit the ability of household and firms to spend, and a huge amount of spare capacity will eventually pull down on inflation (after a near-term increase).

Is QE working? The honest answer is that it is far too early to tell. Yes, there has been an improvement in the economy, and the financial markets are far less stressed than they were. But we simply do not know whether that is because of QE or the raft of other measures that the authorities have put in place over the past two years: over 5% of interest rate cuts, the pound having lost a quarter of its value (which benefits exporters and domestic producers) and the reduction in the rate of VAT.

Given time, we think QE will do its job, and that the economy will look far better a year from now, thanks in part to the Bank's injections of money. What QE has done is to put more money into the hands of the private sector, which in turn has helped reduce borrowing rates and should eventually increase bank lending.

But with the economic recovery likely to be slow and protracted, we should not expect the Bank of England to follow the example set by Israel, Australia and Norway, the first three central banks to raise rates, for some time.